Master Economics and Psychology

Economics of Decision under Risk, Uncertainty and Time

Mohammed Abdellaoui & Olivier L’Haridon

Course description

The course is an introduction to the economics of risk, uncertainty and time. Its objective is two-fold. We first focus on a simplified presentation of the formal foundations of the standard models of rational choice under risk, under uncertainty, and over time. Then, we explore the empirical methods and procedures that allow for a bias-free measurement of preferences and beliefs, including situations where individual behavior departs from standard theories.

Course Outline

FOUNDATIONS (M. Abdellaoui)

Standard Rational Choice Models

1. Expected utility with objective probabilities

2. Expected utility with subjective probabilities

3. Discounted utility

Textbooks:

• Wakker, Peter P. (2010): Prospect Theory for Risk and Ambiguity, Cambridge University Press, Cam- bridge, UK.

• Fishburn, Peter (1970): Utility Theory for Decision Making, John Wiley and Sons, New York.

An Introduction to Prospect Theory

1. The intuition of rank-dependent utility

2. Prospect theory for risk

3. Prospect theory for ambiguity

Articles:

• Diecidue, E., & Wakker, P. (2001). “On the intuition of rank-dependent utility,” Journal of Risk and Uncertainty, 23(3), 281--298.

• Tversky, A., & Wakker, P. (1995). “Risk attitudes and decision weights,” Econometrica 63, 1255- 1280.

• Köbberling, V., & Wakker, P. P. (2005). “An index of loss aversion,” Journal of Economic Theory, 122(1), 119-131.

EMPIRICAL METHODS (O. L’Haridon)


1. Simple methods for eliciting utility under risk

2. The Holt and Laury method

3. Comparison between methods

4. An application: eliciting utility for health states


Articles:

• Hershey, John and Schoemaker Paul (1985), "Probability Versus Certainty Equivalence Methods in Utility Measurement: Are they Equivalent?" Management Science, 31, 1213-1231.

• Holt, Charles, A., and Susan K. Laury. 2002. "Risk Aversion and Incentive Effects," American Economic Review, 92(5): 1644-1655


1. Elicitation biases under risk

2. Parametric methods for general non-expected utility models

3. Non-parametric methods

4. Application: comparing elicitation methods

Articles:

• Abdellaoui,Mohammed,CarolinaBarrios,andPeterP.Wakker(2005),“ReconcilingIntrospective Utility with Revealed Preference: Experimental Arguments Based on Prospect Theory,” Journal of Econometrics, 138, 356-378.

• Hey, J.D. and Orme, C. (1994), “Investigating Generalizations of Expected Utility Theory Using Experimental Data,” Econometrica, 62, 1291-1326.

• Wakker, Peter P. and Daniel Deneffe (1996), "Eliciting von Neumann-Morgenstern Utilities when Probabilities Are Distorted or Unknown," Management Science 42, 1131–1150.

1. Standard methods for eliciting beliefs under uncertainty

2. The source method for eliciting utility under uncertainty

3. Non-parametric elicitations under uncertainty

4. An application: eliciting utility for life duration

Articles and Textbook:

• Abdellaoui, Mohammed, Aurélien Baillon, Laetitia Placido, and Peter P. Wakker. (2011) "The Rich Domain of Uncertainty: Source Functions and Their Experimental Implementation," American Eco- nomic Review, 101(2): 695-723.

• Schotter, Andrew and Isabel Trevino (2014) "Belief Elicitation in the Laboratory,” Annual Review of Economics, 6, 103-128

• Wakker, Peter P. (2010): Prospect Theory for Risk and Ambiguity, Cambridge University Press, Cam- bridge, UK.